How Bad Was It? The worst recession since the great depression. Unemployment rate peaked at 10%. A little higher in 1982, but recent increase from lower level. Median duration of unemployment off the charts. 6% peak to trough decline in total payroll employment – 2X as bad as 1982, previous worst decline Housing starts fell 80%, easily the worst such recessionary drop

Bank lending C&I loans down 25%, and rapidly. Grown last 2 months. Senior loan officer survey -- Record level for net % tightening for C&I loans, at least since survey began (1990). Significant recovery lately Record bank tightening for CRE loans (significant recovery there in last year) Bank credit f(S,D) Net % reporting stronger demand for C&I loans in line with fall in 2001 (note recovery lately)

Market indicators of banking health KBW Bank Index fell 85% from 2007 to March 2009 That index up since that low, but recovery far from complete, and lagging stocks as a whole. –Could be a healthy sign for long run, if market discounting value of future subsidy/future risk constraints Yield spreads still seem to bode well for health of system, future lending

Monetary Aggregates M1, M2 growth actually accelerated as recession intensified, as Fed attempted to liquefy Currency component of M1 – some of the strongest growth since the Y2K episode

Monetary Policy Mandate From the Federal Reserve Act, as amended in 1977 –The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

How did we get here? Moral hazard in government guarantees, support systems for financial markets Broader perspective from the economics of regulation

Moral hazard Once insured, incentive to take more risk Moral hazard vs. morale hazard FDIC, SIPC, Fed discount window, Fed payment system guarantees, can actually cause the risks they are meant to solve. Safety net may actually weaken the system Irony how we got a lesson in moral hazard from an insurance company

Why? Answers in economics of regulation Stigler/Peltzman – regulation generally dominated by regulated. Way to pursue private gains via public purse Lower cost of capital, given public capital behind system Capital regulation – and role of credit ratings –WSJ editorial about a year ago

Market Failure? Markets operate on a bed of law and regulation. Market failure, vs. government failure. Paine, Common Sense –SOME writers have so confounded society with government, as to leave little or no distinction between them; whereas they are not only different, but have different origins. Society is produced by our wants, and government by our wickedness; the former promotes our happiness POSITIVELY by uniting our affections, the latter NEGATIVELY by restraining our vices. The one encourages intercourse, the other creates distinctions. The first is a patron, the last a punisher. –Society in every state is a blessing, but Government, even in its best state, is but a necessary evil; in its worst state an intolerable one: for when we suffer, or are exposed to the same miseries BY A GOVERNMENT, which we might expect in a country WITHOUT GOVERNMENT, our calamity is heightened by reflecting that we furnish the means by which we suffer. Government, like dress, is the badge of lost innocence; the palaces of kings are built upon the ruins of the bowers of paradise.